City Government

Accountability For Non-Profits

Last month, the news broke that the Statue of Liberty remained shuttered for
nearly three years, while the Statue of Libertyâ€“Ellis Island Foundation
guarded a $30 million endowment and paid its top executive annual salaries of nearly $300,000. Press reports questioned why--instead of dipping into its assets to
reopen the symbol of freedom as quickly as possible in the wake of
9/11--the foundation launched a $7 million campaign to improve security. The
foundation’s fundraising and spending activities are now under federal
investigation.

This is just the latest act in government efforts to increase the financial
accountability of foundations and other nonprofits, including many
grantmaking organizations with cultural programs as well as museums, dance
companies, and theaters. In 2003, the House and Senate passed proposals that
would create tax incentives to spur charitable donations, but also would
force foundations to increase the amount they give away each year as a
percentage of their assets. The legislation was widely viewed as spillover
from congressional efforts to tighten regulations of the for-profit sector.

After these proposals stalled in Congress, New York State Attorney General
Eliot Spitzer appealed to the statehouse to introduce legislation for
nonprofits similar to the Sarbanes-Oxley Act, which Congress passed in 2002
in the wake of Enron and other corporate accounting scandals. The
legislation passed
in different versions in New
York’s State Senate and Assembly, but remains in committee. If it becomes
law, it would affect most of the city’s foundations and larger nonprofits.

Sarbanes-Oxley applies to publicly traded companies and their auditors, and
is designed to protect the interest of the shareholding public. The proposed
nonprofit reforms ostensibly would protect the interests of private,
government, and corporate donors. After press reports about nonprofit
mismanagement, there is some evidence that donor faith has eroded. According
to Charity Navigator, a watchdog group, 42 percent of Americans now say they
have less confidence in charities than they did before 9/11. In announcing
the legislation last January, Spitzer argued for the need “to ensure the
integrity of this sector or else people’s contributions will decline.” The
legislation would require nonprofits to certify their financial data,
appoint audit and executive committees, and demonstrate that members of
these committees are free of contracting relationships with the nonprofits
they serve.

But while Spitzer cites a “crisis of accountability” in the nonprofit
sector, many perceive excessive zeal on the part of a man who has gained
power and fame as the state’s top-cop. “There is some flaky management [in
the nonprofit sector],” says Norma Munn, chair of the New York City Arts
Coalition. “Some very talented managers have less accounting knowledge than
is needed when they are in jobs where they have to take on every task. But I
have only encountered one instance of dishonest management.” As director of
an artists’ credit union, Munn cites extensive experience in certifying the
financial records of nonprofits. “The proposed state legislation sets up
further regulating apparatus for which I don’t see a need—I don’t see
problems, don’t hear about problems, and don’t perceive problems in my
dealings with nonprofit groups.”

Spitzer’s supporters argue that, while most nonprofits operate within the
boundaries, some engage in questionable accounting practices that the public
would find inappropriate. “After Sarbanes-Oxley and the attention being
given to the financial dealings of for-profits, we anticipated that this
would happen,” says Jonathan Small, executive director of the Nonprofit
Coordinating Committee of New York (NPCC), an umbrella organization with
1,200 member groups. “Rather than attacking the proposal wholesale, as some
were urging us to do—saying that the nonprofit sector is already regulated
enough—we felt that it would be wise to comment on the proposal, and try to
shape it in a constructive way.”

Stronger Accountability

Some nonprofits have very large boards, and some members of those boards may take only
occasional interest in management practices. The proposed legislation seeks
to create smaller numbers of individuals who feel greater responsibility for
the governance of the organization. It would mandate the creation of audit
committees or require that nonprofits change their by-laws to have full
boards serve as such. It also would require the creation of executive
committees when there are more than 25 board members.

Nonprofits already go through many layers of financial review—for their own
auditors, the auditors of grantmaking organizations, the IRS, and annual
reports. Some argue that further review would prove too burdensome on
organizations in which resources are often stretched thin. Originally, the
proposed legislation would have required verification of financial
information for organizations with annual revenues in excess of $250,000,
but after comment from the Nonprofit
Coordinating Committee of New York and others the ceiling was raised to apply
to groups with annual revenues over $1 million or assets over $3 million.

“Our concern was that nonprofits that already have adequate procedures in
place to certify their financial controls will—because of their concern to
abide by new regulations—spend extra money to do further review, hire
experts, and thus divert money from their programs,” says Small. “We were
concerned that the cost-benefit of this may not be worth it.”

Interested Parties

The legislation would strengthen regulations relating to interested party
transactions, or transactions between a nonprofit and a director doing
business with a nonprofit. A statement on the Nonprofit Coordinating Committee
website expressing support
for this regulation points to
such transactions as “the area in which the worst nonprofit board conduct
occurs.”

“Say a board member sees that a nonprofit needs to rent some office
space, and says that he has some available for $35 a square foot,” Small
explains. “The nonprofit director might think, â€He says that’s a good price,
he’s a good person, let’s take it.’ But maybe it isn’t a good price, and the
nonprofit has been taken advantage of. This legislation gives the attorney
general the ability to ask the board for evidence that the transaction was
â€fair and reasonable’ and to overturn it if it isn’t.” Under current
regulations, if a board approves an interested party transaction, it’s very
difficult for the attorney general to overturn it.

But some argue that this regulation will have a chilling effect on board
development. “The interested party regulation seems to offer the possibility
that relations between personal donors on boards and organizations will be
viewed as suspect,” Munn says. “This has the potential to scare away board
members.” In the still-tough fundraising environment, strong boards are
crucial to the stability and long-term planning of nonprofits. Particularly
for arts groups, board members often bring much-needed financial or legal
expertise.

Given the fact that Albany lawmakers may not be inclined to do Spitzer’s
bidding, there may not be action on this legislation in the near future. But
the threat of action already has spurred change. In February, Independent
Sector, a national coalition of nonprofit organizations and foundations,
released a
code of ethics to its members as
a model for members in their governance and operations. Many groups have
adopted versions of the code.

And, though foundation executives and nonprofit directors argue that further
regulation of their sector is not needed, they acknowledge that they need to
do a better job of explaining their financial realities and management
practices, and the benefits they offer, to the public. Arts groups can draw
on a decade of research—undertaken since the culture wars put culture on the
defensive—showing that the arts reaps significant tangible rewards to
communities and local economies.

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